Oil producers hightail it on spending cuts

Published 11:27 am, Wednesday, January 6, 2016

Rigs stacked along Business 20 west of FM 1788 photographed Tuesday, Feb. 24, 2015. James Durbin/Reporter-Telegram

Rigs stacked along Business 20 west of FM 1788 photographed Tuesday, Feb. 24, 2015. James Durbin/Reporter-Telegram

Photo: James Durbin

Oil producers hightail it on spending cuts

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As crude prices languish below $40 a barrel, American drillers are retreating from domestic oil fields even faster than during the tumultuous 1980s oil bust.

U.S. oil companies are set to curb investments by 24 percent this year to $89.6 billion, meaning that from the beginning of last year to the end of this year, domestic drillers will have cut their annual capital budgets by 51 percent. That’s more than the industrry’s 46 percent cut in the mid-1980s, according to Cowen & Co., which began surveying oil company spending in 1982.

But the oil field exodus eventually will pay off. U.S. crude production surged in recent years, but it began to decline last year. Crude traders are watching domestic output data to figure out when the global oil glut might start to shrink. For the oil market, the faster, the better.

“These conditions will ultimately cleanse the oil patch and set the stage for a sustained up cycle,” said James West, an oil field services analyst at Ever-core ISI, which also has released a spending survey.

The head of the industry’s top trade association struck a similarly upbeat note Tuesday, praising a bipartisan agreement that lifted a 40-year-old ban on U.S. oil exports, while reiterating the group’s frequent criticism of federal energy regulation. Speaking at the American Petroleum Institute’s State of American Energy 2016 event in Washington, institute CEO Jack Gerard said the new era of exports, combined with increased U.S. production, will make the United States a “dominant global figure” in the oil industry.

As evidence, he cited the minimal effect on oil prices even as tensions rose this week between Saudi Arabia and Iran, suggesting that oil supplies have become less sensitive to Mideast turmoil.

“The United States is really emerging as the key energy player in the world,” Gerard said, because the U.S. can produce and export more oil to make up for any potential disruptions within the Saudi-led Organization of the Petroleum Exporting Countries, of which Iran also is a member.

Through the first half of the year, though, it will be rough in the U.S. oil patch.

Cowen & Co. said deep budget cuts are expected to prompt another exodus of drilling rigs from Texas and North Dakota, with the average U.S. land rig count dropping by about 300 this year. Each rig is tied to dozens of oil field jobs, and the Federal Reserve estimates the nation has lost 70,000 U.S. oil and gas jobs already.

To make matters worse for Houston’s oil equipment makers, Cowen’s estimate for the 2016 spending reduction may be too conservative because the survey went out in November, when U.S. oil averaged almost $43 a barrel. U.S. crude since has tumbled further, ending Tuesday’s trading down 79 cents to $35.97, and if prices stay that low for much longer, drillers probably will have to shed more capital dollars than they anticipated.

Evercore ISI’s survey indicated a 19 percent drop in spending this year, but with oil prices lower than they were just two months ago, official budgets may come in 40 percent to 50 percent below initial projections, West said.

The domestic oil industry wasn’t designed to function with $36 oil. Even though some rigs can drill 20 percent more wells and some wells can produce 40 percent more oil, U.S. oil producers’ overall cash flow is expected to come in 35 percent lower this year, the worst haul since 2002, according to Raymond James.

Hidden behind the stark budget cuts is a marked change in the strategy that U.S. oil companies have employed since technological breakthroughs opened up commercial production in dense formations. A record proportion of drillers — 80 percent — are planning to spend within their cash flow this year, according to Evercore ISI.

“This is a record and dwarfs last year’s 55 percent,” West said.

And it’s a big change from the days when shale companies would pile on hundreds of millions in debt to drill wells that have rapidly depleting output levels. For many, it led to a treadmill of taking on debt for nonstop drilling, and historically the vast majority of shale drillers outspent their cash flow from year to year.

“In 2016, boards are almost universally mandating you spend within cash flow,” said David Zusman, managing partner and chief investment officer at Talara Capital Management.

Cowen’s study shows that smaller companies that are more dependent on oil prices and high cash flow are cutting spending more. Companies with budgets less than $100 million slashed 49.6 percent of their investments this year, to a combined $1.2 billion. Bigger companies spending up to $1 billion cut 34.5 percent to $19 billion. The largest drillers with multibillion-dollar budgets cut 19.8 percent, to $69.2 billion. For the larger firms, $36 oil is far less daunting.

“It should be of no surprise that the majority of companies in every category called the economics of drilling poor,” Cowen analysts said. “The one surprise was that there were both independents and majors who called the economics of drilling in the U.S. excellent.”

Evercore ISI believes that by the end of 2016 the oil bust will have shaken out $200 billion in spending around the world